Should We Be Afraid of Friedman's Rule?

Posted: 9 Apr 2001

See all articles by Harald Uhlig

Harald Uhlig

University of Chicago - Department of Economics

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Should one think of zero nominal interest rates as an undesirable liquidity trap or as the desirable Friedman rule? I use three different frameworks to discuss this issue. First, I restate Cole and Kocherlakota's (1998) analysis of Friedman's rule: short run increases in the money stock - whether through issuing spending coupons, open market operations or foreign exchange intervention - change nothing as long as the money stock shrinks in the long run. Second, two simple "Keynesian" models of the inflationary process with a zero lower bound on nominal interest rates imply either that deflationary spirals should be common or that a policy close to the Friedman rule and thus some deflation is optimal. Finally, a formal "baby-sitting coop" model implies multiple equilibria, but does not support the injection of liquidity to restore the good equilibrium, in contrast to Krugman (1998).

Keywords: Friedman's rule, liquidity trap, cash in advance, baby sitting coop, zero lower bound on nominal interest rates, deflation, deflationary spiral, Japan, optimal monetary policy

JEL Classification: E31, E41, E50, E51, E52

Suggested Citation

Uhlig, Harald, Should We Be Afraid of Friedman's Rule?. Journal of the Japanese and International Economics, Vol. 14, pp. 261-303, 2000, Available at SSRN:

Harald Uhlig (Contact Author)

University of Chicago - Department of Economics ( email )

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Chicago, IL 60637
United States

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